Kinetic Concepts 2010 third quarter total revenue increases 2% to $506.7 million

Oct 26 2010

Kinetic Concepts, Inc. (NYSE: KCI):

“I am pleased with our third quarter performance, particularly in our important US V.A.C.® Therapy segment which grew both year-over-year and sequentially”

Third Quarter Highlights

• Worldwide revenue of $506.7 million, up from $504.4 million in the prior-year period as reported and up 2% on a constant currency basis
• Worldwide Active Healing Solutions^TM ("AHS") revenue of $358.4 million, down 1% from the prior-year period as reported; up 1% on a constant currency basis
  • United States AHS revenue of $262.9 million increased 1% compared to the third quarter of 2009
• Worldwide Regenerative Medicine revenue of $84.9 million, up 18% from the prior-year period
• Worldwide Therapeutic Support Systems ("TSS") revenue of $63.4 million, down 12% from the prior-year period and down 10% on a constant currency basis
• Diluted net earnings per share of $1.06, up 16% from the prior-year period
  • Diluted net earnings per share up 11% on an adjusted non-GAAP basis from the prior-year period

Kinetic Concepts, Inc. (NYSE: KCI) today reported third quarter 2010 total revenue of $506.7 million compared to $504.4 million in the third quarter of 2009 and up 2% from the second quarter of 2010. Total revenue for the first nine months of 2010 was $1.49 billion, a 2% increase from the prior-year period. Unfavorable foreign currency exchange rate movements reduced total revenue for the third quarter of 2010 by 1%, while having a nominal impact on total revenue for the first nine months of 2010 compared to the corresponding periods of the prior year.

Net earnings for the third quarter of 2010 were $75.8 million, or $1.06 per diluted share on a GAAP basis, compared to $64.6 million, or $0.91 per diluted share, for the third quarter of 2009, representing increases of 17% and 16%, respectively, from the prior-year period. Third quarter net earnings per diluted share on a non-GAAP basis, excluding non-cash, acquisition-related items were $1.20, up 11% from the prior-year period on a comparable, non-GAAP basis.

"I am pleased with our third quarter performance, particularly in our important US V.A.C.^® Therapy segment which grew both year-over-year and sequentially," said Catherine Burzik, President and Chief Executive Officer of KCI. "Additionally, we are now realizing benefits from our strategic investments: AHS expansion into Japan, LifeCell expansion into EMEA and introduction of innovative therapies including: V.A.C.VIA™, single patient use V.A.C.^® Therapy, ABThera™ for the open abdomen and Prevena™ for surgically-closed incisions. We believe these initiatives hold great promise for our future."

Revenue Recap - Third Quarter and First Nine Months of 2010

Worldwide revenue from AHS products was $358.4 million for the third quarter of 2010 and $1.039 billion for the first nine months of 2010, compared to $360.6 million and $1.039 billion, respectively, for the corresponding periods of 2009. On a constant currency basis, worldwide AHS revenue in the third quarter of 2010 increased approximately 1% from the prior-year period due primarily to higher global rental and sales volumes, partially offset by lower realized pricing. For the first nine months of 2010 worldwide AHS revenue was comparable to the prior-year period.

North American AHS revenue of $275.5 million for the third quarter of 2010 increased 2% from the prior-year period resulting from improved unit volumes. Third quarter 2010 AHS revenue from the United States increased slightly more than 1% from the same period one year ago and 3% sequentially. Revenue of $792.0 million for the first nine months of 2010 was comparable to the same period of the prior year. Foreign currency exchange rate movements had a negligible impact on North American AHS revenue for the third quarter and first nine months of 2010 as compared to the prior-year periods.

EMEA/APAC AHS revenue was $82.9 million for the third quarter of 2010, down from $89.7 million in the prior-year period due primarily to foreign currency exchange rate movements, which unfavorably impacted third quarter EMEA/APAC AHS revenue by 6% compared to the prior-year period. On a constant currency basis, third quarter EMEA/APAC AHS revenue decreased 2% compared to the same period one year ago due largely to continued pricing pressures stemming from increased levels of competitive activity and increased European Union healthcare spending austerity measures, partially offset by increased rental and sales volumes in the region due primarily to the successful launch of V.A.C.^® Therapy in Japan. For the first nine months of 2010, AHS revenue in the EMEA/APAC region was $247.1 million, compared to $247.5 million in the first nine months of 2009. For the first nine months of 2010, foreign currency exchange rate movements negatively impacted EMEA/APAC AHS revenue by 1% compared to the prior year.

Total revenue from our LifeCell division was $84.9 million and $247.7 million for the third quarter and first nine months of 2010, respectively, up 18% from both prior-year periods. Sales of Strattice™, our porcine-based reconstructive tissue matrix, comprised 42% of total Regenerative Medicine revenue for the period, up from 33% in the comparable prior-year period. The EMEA region contributed 2% of the Regenerative Medicine overall revenue growth for both the third quarter and first nine months of 2010 as we continued to penetrate the European markets. We have now introduced our Regenerative Medicine products into eleven European countries.

Total TSS revenue was $63.4 million for the third quarter and $203.5 million for the first nine months of 2010 compared to $72.1 million and $217.5 million, respectively, for the same periods one year ago due primarily to lower rental volumes globally, resulting from continued economic weakness and its impact on acute care facilities, a lower incidence of influenza and unfavorable changes in product mix, partially offset by slightly higher levels of capital sales. Foreign currency exchange rate movements unfavorably impacted worldwide TSS revenue by 2% for the third quarter of 2010 while having no significant impact on the first nine months of 2010 compared to the corresponding prior-year periods.

North American TSS revenue was $41.8 million for the third quarter of 2010, a 10% decrease from the prior-year period, due primarily to fewer hospital therapy days and reduced hospital spending on higher cost therapies, partially offset by increased levels of wound care capital sales. Foreign currency exchange rate movements favorably impacted North American TSS revenue by 1% in the third quarter. North American TSS revenue for the first nine months of 2010 was $134.8 million, down 5% from the prior-year period and down 7% on a constant currency basis. On a constant currency basis, EMEA/APAC TSS revenue decreased 7% for both the third quarter and first nine months of 2010 compared to the same corresponding periods in the prior year due primarily to the impact of prior-year contract losses, as well as utilization changes in select countries and accounts.

Profit Margins

Gross profit for the third quarter and first nine months of 2010 was $289.4 million and $840.9 million, respectively, representing increases of 3% and 5%, respectively, from the same periods of the prior year. Gross profit margin was 57% for the third quarter of 2010, an increase of approximately 130 basis points from the same period one year ago. The gross profit margin increase was due primarily to lower product royalty expenses, increased productivity of our service operations and favorable product mix, specifically, higher gross margins associated with our Regenerative Medicine business unit.

Operating profit for the third quarter and first nine months of 2010 was $120.2 million and $322.8 million, respectively, representing increases of 5% and 1%, respectively, from the same periods one year ago. Third quarter selling, general and administrative ("SG&A") expenses increased $7.1 million, or 5%, over the third quarter of 2009. Third quarter SG&A increases included continued investment associated with our entry into Japan, increased selling costs associated with the growth of our LifeCell division and employee separation costs.

Research and development expenses for the third quarter of 2010 decreased 15% from the prior-year period to $20.9 million. The majority of this decrease was due to the timing of certain programs. Total research and development expenses represented approximately 4% of revenue for the current quarter.

Other Income/Expense Reflects Lower Interest Rates and Focus on Debt Service

Third quarter 2010 interest expense was $21.5 million compared to $25.7 million in the same period of the prior year due to scheduled and voluntary debt payments made over the last twelve months and lower interest rates. Long-term debt outstanding as of September 30, 2010 consisted of a senior secured term loan of $565.0 million due 2013 and 3.25% senior convertible notes of $690.0 million due 2015. Foreign currency transaction gains were $2.1 million in the third quarter of 2010 compared to $3.2 million in the prior-year period due primarily to continued volatility in currency exchange rates.

Income Tax Rate

The effective income tax rate for the third quarter and first nine months of 2010 was 25.0% and 28.0%, respectively, compared to 29.7% and 31.1%, respectively, for the corresponding periods in 2009. The decrease in the effective income tax rate for the third quarter and first nine months of 2010 resulted from a higher percentage of taxable income being generated in lower tax foreign jurisdictions and the favorable resolution of certain tax contingencies during 2010. The resolution of these tax contingencies favorably impacted net earnings by approximately $2.9 million, or $0.04 per diluted share, in the third quarter of 2010.

Financial Position Demonstrates Liquidity and Strength

Total cash at quarter end was $263.3 million compared to $263.2 million at year end 2009. During the third quarter, the Company made scheduled and voluntary senior credit facility repayments of $60.0 million from cash-on-hand. Operating cash flow less net capital expenditures for the first nine months of 2010 was $179.6 million, a decrease of $28.8 million from the same period one year ago due to increases in inventory levels of our Strattice and AlloDerm tissue matrices, and increased income tax payments, partially offset by improved cash collections and higher net earnings. Total long-term debt outstanding at September 30, 2010 was $1.137 billion on a GAAP basis and $1.255 billion on an economic, or debt-instrument, basis. As of September 30, 2010 and December 31, 2009, these convertible notes had balances of $572.0 million and $556.2 million, respectively, within our condensed consolidated balance sheets.

Outlook

The Company is reaffirming its 2010 revenue guidance and raising its earnings per share guidance, based on current information and expectations as of October 26, 2010 (in millions, except per share data) as follows:

The revenue guidance, relative to 2009, reflects our expectation of continuing volatility in foreign currency exchange rates, stable revenue in our AHS business, double-digit growth in Regenerative Medicine revenue and a high single digit contraction in our TSS business. In addition, our GAAP earnings per share guidance and the lower end of our adjusted, non-GAAP earnings per share guidance range have been adjusted to reflect the strong earnings performance reported for the third quarter of 2010.

Non-GAAP Financial Information

Within this document, we have included our results for the third quarter and nine months ended September 30, 2010 along with our outlook on a non-GAAP basis to exclude the impact of the specified non-cash expenses set forth above associated with our acquisition of LifeCell in the second quarter of 2008 and the impact of restructuring and other significant charges incurred during the first quarter of 2009 and the second quarter of 2010. In addition, we have presented supplemental revenue data on a non-GAAP basis to exclude the impact of foreign currency fluctuations between 2009 and 2010. These non-GAAP financial measures do not replace the presentation of our GAAP results and outlook. We have provided this supplemental non-GAAP information because it may provide meaningful information regarding our results and outlook on a basis that better facilitates an understanding of our expected results of operations which may not be otherwise apparent under GAAP. Management uses this non-GAAP financial information, along with GAAP information, for reviewing its operating results and for analyzing potential future business trends. In addition, we believe some investors may use this information in a similar fashion. A reconciliation of our GAAP selected financial information for the periods presented to the non-GAAP selected financial information provided is included herein.